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and Healthcare Organizations by Michael Nowicki. This sample contains the
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Tax Status of Healthcare
Organizations
Tax Status
Tax Status of Healthcare
Organizations
Learning Objectives
1. Analyze the rationale for tax-exempt status and apply the rationale to
healthcare.
2. Appreciate the value of tax-exempt status.
3. Identifyy the steps
p necessary
y to q
qualify
y for tax-exempt
p status.
4. Relate the importance of community benefits to tax-exempt status in healthcare.
5 Examine judicial challenges to tax-exempt status
5.
status.
6. Examine legislative challenges to tax-exempt status.
7. Examine IRS challenges to tax-exempt status.
Tax Status
Tax Status of Healthcare
Organizations
• For-profit organizations pay taxes
Tax Status
Tax Status of Healthcare
Organizations
• For-profit organizations pay taxes.
– Federal and state income tax on their income
– State and local sales tax on their purchased
goods/services
– Local real estate and personal property tax on
their land, buildings, and major equipment
Tax Status
Tax Status of Healthcare
Organizations
• Nonprofit organizations pay no taxes.
Tax Status
Rationale for Tax-Exempt
Tax Exempt Status
Tax Status
Rationale for Tax-Exempt
Tax Exempt Status
• Relieves the government of the burden of
providing services.
Tax Status
Rationale for Tax-Exempt
Tax Exempt Status
• Relieves the government of the burden of
providing services.
• Rewards the organization for performing
services that enhance beneficial community
values
l
and
d goals.
l
Tax Status
Value of Tax-Exempt Status for 122Bed Hospital
$1 469 000
$1,469,000
F d l IIncome Tax
Federal
T
State Income Tax
334,000
Real Estate Tax
155 000
155,000
Personal Property Tax
84,000
Cityy Property
p y Tax
24,000
2,066,000
Total Tax Liability
Business Licenses/Fees
150,000
Incremental Debt Cost
900,000
Total Value of Tax-Exempt Status
Tax Status
$3,116,000
Qualifying for Tax-Exempt Status
[501(C)3]
Tax Status
Qualifying for Tax-Exempt Status
[501(C)3]
• Operate exclusively for charitable, scientific,
or educational reasons.
Tax Status
Qualifying for Tax-Exempt Status
[501(C)3]
– Revenue Ruling 56-185: financial ability standard-provide care to those who can’t afford to pay for care
– Revenue
R
R
Ruling
li 69
69-545:
545 community
it benefits
b
fit standard-t d d
promoted health deemed beneficial to the community
((I.e. emergency
g
y rooms))
– Revenue Ruling 83-157: emergency room exemptions
if services were duplicated
Tax Status
Qualifying for Tax-Exempt Status
[501(C)3]
• Serve public, rather than private, interests, in
that income may not inure to the benefit of
individuals.
Tax Status
Qualifying for Tax-Exempt Status
[501(C)3]
• Cannot engage in prohibited transactions
including, but not limited to, the following:
Tax Status
Qualifying for Tax-Exempt Status
[501(C)3]
– Participate in political campaigns
– Attempt to influence legislation
– Lend anyy part
p of income with receiving
g adequate
q
security
y and
interest
– Pay any compensation in excess of reasonable salary levels
– Make any investments for more than adequate consideration
– Sell any asset for less than adequate consideration
– Subvert in any manner substantial portions of income or assets
– Make any part of services available on a preferential basis
Tax Status
Is there a significant difference
between the amount of community
benefits offered byy nonprofit and forprofit hospitals?
Tax Status
Is there a significant difference?
• Relman (1980)--medical-industrial complex
Tax Status
Is there a significant difference?
• Relman (1980)--medical-industrial complex
g ((1983)--for-profit
)
p
hospital
p
• Bromberg
spokesperson
Tax Status
Is there a significant difference?
• Herzlinger & Krasker (1987) study
Tax Status
Is there a significant difference?
• Herzlinger & Krasker (1987) study--no
significant difference in community benefits.
Tax Status
Is there a significant difference?
• Sloan, Valvona, and Mullner (1986) study--no
significant difference in the delivery of
uncompensated care.
Tax Status
Is there a significant difference?
• Gray (1986) study--no significant difference in
scope of services.
Tax Status
Is there a significant difference?
• Witek, Milligan, and Ryan (1993) study-including taxes as a community benefit, forprofit hospitals provide significantly more
community benefits.
Tax Status
Is there a significant difference?
– 1991 Georgia Hospitals
– % off adjusted
dj t d gross revenue
Ownership
Indigent care
Taxes
Total Benefit
County
6.0
(4.0)
2.0
N
Nonprofit
fit
41
4.1
00
0.0
41
4.1
For-profit
2.5
3.9
6.4
Tax Status
Is there a significant difference?
U.S. News and World Report 1995 study--the Government
Accountability Office found that nonprofit hospitals provided 4.8
percent of gross revenues in indigent care while for-profit
hospitals provided 5.2 percent.
U.S. News and World Report noted that nonprofit hospitals
represented approximately $15 billion in lost tax revenue due to
their tax-exempt status.
Tax Status
Is there a significant difference?
• Morrisey, Wedig, and Hassan (1996) study-found that 80.4 percent of California’s
nonprofit hospitals provided uncompensated
care (both charity care and bad debt) in
excess of their tax subsidies
subsidies, or their potential
tax liabilities, which averaged $1,579,000.
Tax Status
Is there a significant difference?
• In 2004, Richard Scruggs began seeking
class-action status in 49 lawsuits accusing
370 nonprofit hospitals of overcharging the
uninsured and using aggressive collection
methods against poor patients
patients.
Tax Status
Is there a significant difference?
• The lawsuit against the Providence Health
System, which operates several hospitals in
Washington state and Oregon
Oregon, is
representative. Citing the Providence mission
to p
provide “universal access to health care,,
social justice and compassion for all
members of our society” with “special
concern for the poor and vulnerable
vulnerable,”
Scruggs (2004) argued
Tax Status
Is there a significant difference?
In fact, contrary to these representations, Providence discriminates against the
very patients who are supposed to benefit most from its charity care by engaging
in a ppattern and ppractice of charging
g g inordinatelyy inflated rates to its uninsured
patients, including Plaintiffs and the Class they seek to represent, that are far
higher than the rates it charges its insured patients for the same services.
Providence publicly represents itself as a 'not-for-profit medical care provider,’
and it receives millions of dollars each year in tax exemptions under
Section 501(c)(3) of the federal tax code,
code 26 U.S.C.
U S C §501(c)(3),
§501(c)(3) as a charitable
charitable,
'non-profit' organization that is required by law to engage in exclusively
charitable purposes. Providence Oregon is similarly exempt from Oregon
property taxes based on its charitable
charitable, 'non-profit'
non-profit status.
status
Tax Status
Is there a significant difference?
In fact, again contrary to its representations, Providence is extremely profitable.
For example, in 2002, which is the most recent year for which data is available,
Providence Oregon
g obtained over $1.2 billion in revenue,, it held over $250
million in cash and investment securities, and the cost of its physical plant (land,
buildings and equipment) was over $1.1 billion.
The same year, Providence Oregon's President and CEO, Henry G. Walker,
received over $1.4 million in compensation and benefits, its four Vice
Presidents received an average of over $565,000
$565 000 in compensation and benefits,
benefits
and the average compensation and benefits of its five highest paid employees
other than officers and directors was $460,000.
Tax Status
Is there a significant difference?
• In 2006, Providence Health System, along with
Legacy Health System and Sutter Health, settled
the uninsured billing cases while denying
wrongdoing.
– Providence will be refunding or adjusting $1 million in past bills that
do not meet the following discount policy agreed to as part of the
settlement: uninsured patients regardless of income will receive a
discount equal to the average managed care discount from the
previous year; additional discounts are dependent on a sliding
scale based on income up to 400 percent of the federal poverty
level (Becker 2006a).
Tax Status
Is there a significant difference?
• 2006 Community Benefits Standards
– AHA argues that the cost of bad debt as well as charity care along
with losses to both Medicare and Medicaid should be counted.
– Catholic Health Association (CHA) argues that the cost of bad debt
and the loss to the Medicare program should not be counted
– HFMA P&P Board Statement #15 is consistent with the CHA
standard.
Tax Status
Is there a significant difference?
• December 2006 Congressional Budget Office
(CBO) report on the provision of community
benefits by nonprofit hospitals
hospitals.
– Both for-profit and nonprofit hospitals in five states, California,
Florida, Georgia, Indiana, and Texas, were examined (n=1,057).
– Acknowledging
A k
l d i th
the llack
k off iindustry
d t consensus on what
h t constitutes
tit t
community benefits and how such benefits should be measured,
the CBO report defined community benefits as the provision of
p
care,, the provision
p
of services to Medicaid
uncompensated
patients, and the provision of certain specialized services that have
been traditionally identified as unprofitable.
Tax Status
Is there a significant difference?
– The CBO found, on average, that nonprofits provided higher levels
of uncompensated care and were more likely to provide
unprofitable specialized services.
– For-profit hospitals provided care to more Medicaid patients as a
percent of their total patient population, and for-profit hospitals
were found to operate in areas with lower average incomes, higher
poverty rates
rates, and higher rates of uninsured
uninsured.
– The CBO also reported the results of the Joint Committee on
Taxation, which valued the total tax exemptions for the nation's
nonprofit hospitals for 2002 at $12.6 billion, with exemptions from
federal taxes accounting for about half of the total.
Tax Status
Judicial Challenges to Tax-Exempt
Status
Tax Status
Judicial Challenges to Tax-Exempt
Status
• Board of Equalization of Utah County v.
Intermountain Health Care, 709 P.2d 265
(Utah, 1985).
Tax Status
Judicial Challenges to Tax-Exempt
Status
“Tax exemptions confer an indirect subsidy and are usually justified
as the quid pro quo [consideration] for charitable entities
undertaking functions and services that the state would
otherwise be required to perform. A concurrent rationale used
by some courts, is the assertion that the exemptions are granted
not only because charitable entities relieve government of a
burden, but also because their activities enhance beneficial
community values and goals. Under this theory, the benefits
received by the community are believed to offset the revenue
lost by reason of the exemption”
exemption (emphasis added)
added).
Tax Status
Judicial Challenges to Tax-Exempt
Status
• State of Texas v. Methodist Hospital, 1988.
Tax Status
Judicial Challenges to Tax-Exempt
Status
• State of Texas v. Methodist Hospital, 1988.
– Attorney General Maddox filed suit against
Methodist for providing inadequate charity care.
Tax Status
Judicial Challenges to Tax-Exempt
Status
• State of Texas v. Methodist Hospital, 1988.
– Methodist attempted to defend itself, citing large
amounts of contractual allowances as community
benefits.
Tax Status
Judicial Challenges to Tax-Exempt
Status
• State of Texas v. Methodist Hospital, 1988.
– Attorney General Maddox appointed task force,
which sided with Methodist.
Tax Status
Judicial Challenges to Tax-Exempt
Status
• State of Texas v. Methodist Hospital, 1988.
– District judge dismissed the case against
Methodist in 1993, explaining that Methodist had
broken no state laws.
Tax Status
Judicial Challenges to Tax-Exempt
Status
• State of Texas v. Methodist Hospital, 1988.
– Local tax appraisal district sent letters to Methodist
Hospital and other nonprofit hospitals in Harris
County asking for data to support tax-exempt
status.
Tax Status
Judicial Challenges to Tax-Exempt
Status
• State of Texas v. Methodist Hospital, 1988.
– Governor appointed the Texas Health Policy Task
Force, which made a 1993 recommendation to the
legislature that nonprofit hospitals provide
community benefits equal to the value of their
local and state tax-exempt benefits (see Texas SB
427).
Tax Status
Judicial Challenges to Tax-Exempt
Status
• St. Luke’s Regional Medical Center, Boise,
Idaho
– C
County
t authorities
th iti sentt a $3
$3.4
4 million
illi property
t ttax bill iin
1997 based on the following:
• Hospital was not sufficiently supported by donations.
• Recipients of services at the hospital were expected to pay
pay.
• Hospital did not provide community benefit because the costs
of charity care and bad debts were shifted to other patients.
• Hospital was too profitable--8.9% net income.
Tax Status
Judicial Challenges to Tax-Exempt
Status
• Harrisburg Hospital, Harrisburg, Pennsylvania
– In 1998, an appeals court upheld the revocation of the
hospital’s tax
tax-exempt
exempt status,
status because it had not been
operated free of the profit motive:
•
•
•
•
Hospital passed surpluses to corporate parent.
Hospital’s CEO made $400
$400,000.
000
Hospital’s bonus plan included financial goals.
Hospital required physicians sign noncompete clauses.
Tax Status
Judicial Challenges to Tax-Exempt
Status
• Dartmouth-Hitchcock Medical Center in
Lebanon, New Hampshire
– In 1998, city revoked tax-exempt status and sent hospital
$6.5 million tax bill based on the following:
• Hospital had collection policy that encouraged full pay.
• Hospital provided 2.9% of revenue in charity care, an
amount also provided by for-profit hospitals.
Tax Status
Judicial Challenges to Tax-Exempt
Status
St. David’s/HCA v. IRS
– IRS assessed $1.2 million in 1996
– St. David’s paid, but filed suit
– Both sides agreed the 1997-2001
1997 2001 that were owed would not
be paid pending outcome of the suit
– June 7, 2002, St. David’s won in federal district court
– September, 2002, federal government appeals decision to
fifth circuit
– November 7, 2003, fifth circuit overruled district court
decision and sent the case back for trial.
Tax Status
Judicial Challenges to Tax-Exempt
Status
St. David’s/HCA v. IRS
–
In reversing the trial court, the fifth circuit said:
“If
If more than an insubstantial amount of the
partnership’s activities further non-charitable
interests, then St. David’s can no longer be
deemed to operate exclusively for charitable
purposes. Therefore, even if St. David’s performs
important charitable functions, St. David’s cannot
qualify for tax
tax-exempt
exempt status...if
status if its activities
substantially further the private, profit-seeking
interests of HCA.”
Tax Status
Judicial Challenges to Tax-Exempt
Status
St. David’s/HCA v. IRS
– On March 4, 2004, the trial court determined that St. David’s
had not ceded control and therefore returned a verdict in
favor of St. David’s.
– In May 2004, U.S. Justice Department announced that it had
decided not to appeal the March 4 jury decision. Had St.
David’s lost the appeal, it would have owed more than $40
million in back taxes and penalties
penalties.
Tax Status
IRS Challenges to Tax-Exempt
Status
• Responding to public pressure to reduce
federal budget deficits, the IRS began
auditing tax-exempt organizations in 1987.
Tax Status
IRS Challenges to Tax-Exempt
Status
• By 1992, the IRS had audited 233 tax-exempt
healthcare organizations and found frequent
irregularities in physician recruiting
arrangements (Herman Hospital) and
unrelated business income
income.
Tax Status
IRS Challenges to Tax-Exempt
Status
• 1991 Coordinated Examination Program
(CEP).
• 1992 IRS Tax Audit Guide for Tax-Exempt
Hospitals
– Community benefit standard including instances of
patient dumping
Tax Status
IRS Challenges to Tax-Exempt
Status
• 1991 Coordinated Examination Program
(CEP).
• 1992 IRS Tax Audit Guide for Tax-Exempt
Hospitals
– Unreasonable compensation and private
inurement
Tax Status
IRS Challenges to Tax-Exempt
Status
• 1991 Coordinated Examination Program
(CEP).
• 1992 IRS Tax Audit Guide for Tax-Exempt
Hospitals
– Financial analysis of affiliated entities and
unrelated business income
Tax Status
IRS Challenges to Tax-Exempt
Status
• 1991 Coordinated Examination Program
(CEP).
• 1992 IRS Tax Audit Guide for Tax-Exempt
Hospitals
– Joint ventures--hospitals had six months to
rescind relationships
Tax Status
IRS Challenges to Tax-Exempt
Status
• 1991 Coordinated Examination Program
(CEP).
• 1992 IRS Tax Audit Guide for Tax-Exempt
Hospitals
– Independent contractors
Tax Status
IRS Challenges to Tax-Exempt
Status
• By June,
June 2000
2000, the IRS had identified 875
audit candidates. The first 63 audits closed
with an average
g assessment of $
$2.5 million
and an average audit length of three years.
Tax Status
IRS Challenges to Tax-Exempt
Status
• In 2006,
2006 in conjunction with the Exempt
Organization Compensation Initiative, the IRS
sent compensation
p
q
questionnaires ((Form 13790))
to approximately 600 tax-exempt hospitals. The
initiative was triggered by incomplete or
insufficient answers to Form 990 for 2005, which
resulted in 200 examinations.
Tax Status
IRS Challenges to Tax-Exempt
Status
• In 2005
2005, the IRS announced its intent to broaden
its interpretation of responsibility for excess-benefit
transactions. Previously, the IRS investigated only
excess-benefit
b
fit ttransaction
ti participants
ti i
t and
d only
l if
the participants personally benefited from the
transaction. In the future, IRS intends to
investigate the organization involved with possible
intermediate sanctions or tax-exemption
revocation.
ti
Tax Status
IRS Challenges to Tax-Exempt
Status
• Typically the excess benefit was a transaction with
a party external to the organization, like a
physician receiving inflated amounts for clinical
services
i
rendered
d d tto th
the h
hospital,
it l receiving
i i
excessive payments for administrative medical
director services, or below market-rate
market rate rent for
office space provided by the hospital. Note that
these transactions may also violate kickback
statutes
t t t if entered
t d into
i t in
i exchange
h
for
f referrals.
f
l
Tax Status
IRS Challenges to Tax-Exempt
Status
• However
However, excess
excess-benefit
benefit transactions can also
occur with a party internal to the organization.
y regarding
g
g
• In 2006, there was a flurryy of activity
executive compensation. Such compensation, if
viewed as excessive, can fit squarely in the
excess benefit transaction prohibitions
excess-benefit
prohibitions.
Tax Status
Federal Legislative Challenges to
Tax-Exempt Status
Tax Status
Federal Legislative Challenges to
Tax-Exempt Status
• Attempts by Rangel (D-NY), Donnelly (D-MA),
and President Clinton have failed.
Tax Status
Federal Legislative Challenges to
Tax-Exempt Status
• Taxpayer Bill of Rights II, which was signed
into law in 1996
–R
Requires
i
ttax-exemptt organizations
i ti
t disclose
to
di l
excess-benefit transactions on Form 990 each
year
– Expands public access to Form 990
– Executives pay a 10 percent tax on the amount of
the excess if corrected and reported, 200 percent
tax on unreported excesses that executives
personally benefited
Tax Status
Federal Legislative Challenges to
Tax-Exempt Status
• IRS made the following changes to be
effective in 2003
– Information on fund-raising activities
– Information on corporate responsibility practices
– Information
I f
ti on grants
t to
t foreign
f i organizations
i ti
– see www.irs.gov/individuals/lists/0,,id=98200,00.html
Tax Status
State Legislative Challenges to TaxExempt Status
Tax Status
State Legislative Challenges to TaxExempt Status
• Texas Senate Bill 427 signed into law in
1993.
Tax Status
State Legislative Challenges to TaxExempt Status
• Texas Senate Bill 427 signed into law in
1993.
–E
Establishes
t bli h a llegall d
duty
t ffor nonprofit
fit h
hospitals
it l tto
provide community benefits (unreimbursed costs
of providing charity care patients and
unreimbursed
i b
d costs
t off providing
idi care to
t Medicaid
M di id
patients) in amounts equal to
• 4 percent of the hospital’s net revenues
• 100 percent of the hospital’s state and local tax
exemptions
Tax Status
State Legislative Challenges to TaxExempt Status
• Texas Senate Bill 427 signed into law in
1993.
• Texas Hospital Association analyzed the bill
and announced that in the aggregate,
member
b h
hospitals
it l should
h ld h
have no problem
bl
meeting the requirement.
Tax Status
State Legislative Challenges to TaxExempt Status
• As of June 2001, six states have passed
mandatory community-benefit legislation-Texas California,
Texas,
California Georgia
Georgia, Indiana
Indiana, New
York, and Pennsylvania--while three states
have p
passed voluntary
y community-benefit
y
legislation--Massachusetts, Missouri, and
Oregon.
Tax Status
State Legislative Challenges to TaxExempt Status
• In 2005,
2005 the attorney general of Minnesota
reached agreements with more than 50
hospitals
p
on billing
g and collection p
practices for
uninsured patients.
• In 2005, the attorney general of Kansas is
working
ki with
ith th
the state
t t h
hospital
it l association
i ti tto
establish best practices in billing and
collection practices.
p
Tax Status
State Legislative Challenges to TaxExempt Status
• In 2006,
2006 after Illinois upheld the revocation of
Provena Covenant's tax exemption from local
property
p
p y taxes, the state’s attorney
yg
general
proposed two bills-– the charity care bill (which did not come up for a
vote in 2006) required tax-exempt hospitals to
spend 8 percent of their operating costs on charity
care;
– the collections bill ((which
hich passed and takes effect
in 2007) restricts hospital debt-collection efforts.
Tax Status